Bad debt buck has to stop somewhere

Enron, Global Crossing, Kmart: these three companies alone probably account for more than $200 billion of debts which have gone sour. Add in others such as NTL, Marconi, Energis and a host of other technology companies at risk of default and the potential losses could be more than double that. But just who is picking up the tab?

The answer from everyone appears to be: someone else. Not us, say the banks: we have laid off our risk to the bond markets, shareholders or insurance companies. Not us, say the insurance companies: we would never write policies that exposed us to that much risk. You may think we will be the losers, say the bondholders, but don't you remember how many banks we held to ransom during the recession of the 1990s.

Shareholders are certainly picking up part of the tab: just look at ICI's decision to launch an £800 million rights issue to avoid a downgrading of its debt. Others are likely to follow the chemicals group to their shareholders, but that will not be an escape route the most troubled companies can use. What is certain is that risk never disappears: someone will end up paying for the lending binge which ended the last millennium. And the regulators are working hard to find out just who.

Howard Davies, chairman of the Financial Services Authority, had another go last week when he expressed concern about 'collateralised debt obligations'. In layman's language, that means parceling up loans or bonds and selling them on to insurance companies and other investors - which, he said, had been described as 'the most toxic element of the financial markets today'.

An article in Euromoney at the end of last year suggested that three banks - Citigroup, Bank of America and JP Morgan - accounted for 90 per cent of these credit insurance products.

No insurer has yet owned up to being the counterparty on these deals, although insurance analysts say the big players are likely to be Lloyd's syndicates, big reinsurers such as M&G Re and Munich Re and possibly also European firms like AIG.

The bigger question is whether they work. Given that JP Morgan is currently taking legal action against a group of insurers claiming payment of $1.1bn related to its Enron liabilities, that is at least open to question.

Certainly, investors seem prepared to give British banks the benefit of the doubt. Since the market hit its low point last September, the banking sector has outperformed the rest of the market by a third as shareholders gambled that loan write-offs would not be that great.

There will undoubtedly be pockets of bad news: Abbey National has admitted to £115 million of exposure to Enron; HSBC may have to write off as much as £1bn of its lending to Argentina. And, overall, analysts expect provisions last year to be as much as a third higher than in 2000. But, in a historical context, that is still not high.

Peter Toeman, banking analyst with Morgan Stanley, expects provisions to peak at less than 1 per cent of total lending, compared with more than 2 per cent in the 1990s, when Barclays plunged into loss and cut its dividend. This is partly because UK banks are not too exposed to the troubled areas - telecoms lending, for example, accounts for less than 2 per cent of loan books. It is also partly because interest rates are low and unemployment, although rising, is still not unduly troubling the solid businesses which account for the bulk of British lending. Indeed, the latest figures from Dun & Bradstreet suggest corporate failures actually fell in the last quarter of last year.

Will that continue? The banks and the analysts insist it will; the regulators are urging caution - not just about corporate lending but about the build-up of debt in the personal sector too.

'Are we being over-optimistic about the next 18 months?' asked one banking executive. 'It is difficult to tell. Previous recessions have been characterised by high volatility, high unemployment and high interest rates.

'Now, we have relative stability and low interest rates. But there are signs of deterioration. The number of companies going into our "sick bays" is increasing.'